BackRupee, RBI and the problem of plenty
RBI not only needs to address the liquidity surplus but also prevent an accretion of it from fickle dollar inflows, which if left unattended, the rupee's overvaluation will begin to look alarming sooner than later
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On 15 January 2008, the Indian rupee touched the level of 39.26 to a dollar, its strongest since liberalization.
The rise came despite the relentless efforts by the Reserve Bank of India (RBI) to curb its appreciation, one of which was to add a massive $78 billion to the forex reserves and issue market stabilization scheme (MSS) bonds worth close to Rs2 trillion to mop up the excess liquidity.
In 2007, the rupee had surged 11% against the dollar.
Fast forward to now.
The currency has gained 4.5% in the present quarter and, according to Bloomberg, this is its best first quarter of any calendar year since 1975.
Should the exchange rate start worrying RBI, corporate entities and even investors?
It has already begun to perturb investors of export-oriented companies that are directly exposed to the exchange rate’s appreciation.
So far this year, the BSE IT index and the BSE healthcare index have risen 2.18% and 3.77%, respectively, but have underperformed the benchmark 30-share Sensex.
It is indeed unfortunate that the currency’s rapid rise comes just when India’s exports have begun to improve.
Exports grew for the seventh consecutive month in February, reinforcing hopes of a revival after a prolonged slowdown since December 2014.
Also, the companies that hedged their forex borrowings, believing the rupee will depreciate, will feel short-changed now. Some may even incur losses and cut their hedges. But an appreciating currency is a boon for a net importing country like India. It reduces the import bill and, thereby, dampens inflation, something that RBI would be more than happy with right now as crude oil prices have begun to rise.
But seldom is the relationship between the exchange rate and inflation so clear and linear. The dollar flows that are behind the rising rupee tend to distort asset prices as these are volatile and fickle.
Flows to the debt market will suppress yields, and RBI can ill afford the addition to an already colossal level of liquidity surplus. Corporate bond yields are down over 50 basis points and the benchmark equity indices have soared over 20% in FY17. One basis point is one-hundredth of a percentage point.
RBI not only needs to address the liquidity surplus but also prevent an accretion of it from fickle dollar inflows. Left unattended, the overvaluation of the rupee would begin to look alarming sooner than later.
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